Taking into account the annual capital allowances for the machine, the annual tax liability and the annual cash flows, evaluate the viability of the four-year contract to supply the components.
Jireh Limited also manufactures prefab components for the housing industry. They have just been offered a new four year contract to supply a component, subject to them meeting certain quality requirements set by GREDA Ghana. The production manager is concerned that the current machine, which has been fully depreciated, will not be able to meet the stringent quality controls that will be required because the technology is obsolete, and the machine is unreliable. The company currently spends £50,000 per year to maintain and operate this machine which has no secondhand market value. On the basis of the production managerʼs recommendation, management has decided to replace the current machine. It is estimated that the replacement machine will cost £1 million with a four-year useful life. The companyʼs depreciation policy is to use a 20%
1. Revenues and Costs – The estimated annual revenues and costs from the project for the next four years are:
Year Revenues (in £) Costs (in £)
1 800,000 350,000
2 850,000 385,000
3 880,000 410,000
4 920,000 435,000
2.
(i) Capital allowances – The new machine will attract a 20% declining balance writingdown allowance each year.
(ii) The company pays corporate tax at a rate of 20% of taxable profit and this is paid in the year the profit is generated.
3. It is estimated that the machine will be sold for £350,000 at the end of year 4
4. The company uses an after tax cost of capital of 18% for investments of this risk class.
Required:
(i) Taking into account the annual capital allowances for the machine, the annual tax liability and the annual
Step by step
Solved in 3 steps with 3 images
